Introduction to the First Edition

The year 1929 stands as the great American trauma. Its shock impact on American thought has been enormous. The reasons for shock seem clear. Generally, depressions last a year or two; prices and credit contract sharply, unsound positions are liquidated, unemployment swells temporarily, and then rapid recovery ensues. The 1920–1921 experience repeated a familiar pattern, not only of such hardly noticeable recessions as 1899–1900 and 1910–1912, but also of such severe but brief crises as 1907–1908 and 1819–1821.1 Yet the Great Depression that ignited in 1929 lasted, in effect, for eleven years.

In addition to its great duration, the 1929 depression stamped itself on the American mind by its heavy and continuing unemployment. While the intensity of falling prices and monetary contraction was not at all unprecedented, the intensity and duration of unemployment was new and shocking. The proportion of the American labor force that was unemployed had rarely reached 10 percent at the deepest trough of previous depressions; yet it surpassed 20 percent in 1931, and remained above 15 percent until the advent of World War II.

If we use the commonly accepted dating methods and business cycle methodology of the National Bureau of Economic Research, we shall be led astray in studying and interpreting the depression. Unfortunately, the Bureau early shifted its emphasis from the study of the qualitatively important periods of “prosperity” and “depression,” to those of mere “expansion” and “contraction.” In its dating methods, it picks out one month as the peak or trough, and thus breaks up all historical periods into expansions and contractions, lumping them all together as units in its averages, regardless of importance or severity. Thus, the long boom of the 1920s is hardly recognized by the Bureau—which highlights instead the barely noticeable recessions of 1923 and 1926. Furthermore, we may agree with the Bureau—and all other observers—that the Great Depression hit its trough in 1932–1933, but we should not allow an artificial methodology to prevent our realizing that the “boom” of 1933–1937 took place within a continuing depression. When unemployment remains over 15 percent, it is folly to refer to the 1933–1937 period as “prosperity.” It is still depression, even if slightly less intense than in 1933.2

The chief impact of the Great Depression on American thought was universal acceptance of the view that “laissez-faire capitalism” was to blame. The common opinion—among economists and the lay public alike—holds that “Unreconstructed Capitalism” prevailed during the 1920s, and that the tragic depression shows that old-fashioned laissez-faire can work no longer. It had always brought instability and depression during the nineteenth century; but now it was getting worse and becoming absolutely intolerable. The government must step in to stabilize the economy and iron out the business cycle. A vast army of people to this day consider capitalism almost permanently on trial. If the modern array of monetary–fiscal management and stabilizers cannot save capitalism from another severe depression, this large group will turn to socialism as the final answer. To them, another depression would be final proof that even a reformed and enlightened capitalism cannot prosper.

Yet, on closer analysis, the common reaction is by no means self-evident. It rests, in fact, on an unproven assumption—the assumption that business cycles in general, and depressions in particular, arise from the depths of the free-market, capitalist economy. If we then assume that the business cycle stems from—is “endogenous” to—the free market, then the common reaction seems plausible. And yet, the assumption is pure myth, resting not on proof but on simple faith. Karl Marx was one of the first to maintain that business crises stemmed from market processes. In the twentieth century, whatever their great positive differences, almost all economists—Mitchellians, Keynesians, Marxians, or whatnot—are convinced of this view. They may have conflicting causal theories to explain the phenomenon, or, like the Mitchellians, they may have no causal theory at all—but they are all convinced that business cycles spring from deep within the capitalist system.

Yet there is another and conflicting tradition of economic thought—now acknowledged by only a few economists, and by almost none of the public. This view holds that business cycles and depressions stem from disturbances generated in the market by monetary intervention. The monetary theory holds that money and credit-expansion, launched by the banking system, causes booms and busts. This doctrine was first advanced, in rudimentary form, by the Currency School of British classical economists in the early nineteenth century, and then fully developed by Ludwig von Mises and his followers in the twentieth. Although widely popular in early-nineteenth-century America and Britain, the Currency School thesis has been read out of business cycle theory and relegated to another compartment: “international trade theory.” Nowadays, the monetary theory, when acknowledged at all, is scoffed at as oversimplified. And yet, neither simplicity nor single-cause explanation is a defect per se in science; on the contrary, other things being equal, science will prefer the simpler to the more complex explanation. And science is always searching for a unified “single cause” explanation of complex phenomena, and rejoices when it can be found. If a theory is incorrect, it must be combatted on its demerits only; it must not be simply accused of being monocausal or of relying on causes external to the free market. Perhaps, after all, the causes are external—exogenous—to the market! The only valid test is correctness of theoretical reasoning.

This book rests squarely on the Misesian interpretation of the business cycle.3 The first part sets forth the theory and then refutes some prominent conflicting views. The theory itself is discussed relatively briefly, a full elaboration being available in other works. The implications of this theory for governmental policy are also elaborated—implications which run flatly counter to prevailing views. The second and third parts apply the theory to furnish an explanation of the causes of the 1929 depression in the United States. Note that I make no pretense of using the historical facts to “test” the truth of the theory. On the contrary, I contend that economic theories cannot be “tested” by historical or statistical fact. These historical facts are complex and cannot, like the controlled and isolable physical facts of the scientific laboratory, be used to test theory. There are always many causal factors impinging on each other to form historical facts. Only causal theories a priori to these facts can be used to isolate and identify the causal strands.4 For example, suppose that the price of zinc rises over a certain time period. We may ask: why has it risen? We can only answer the question by employing various causal theories arrived at prior to our investigation. Thus, we know that the price might have risen from any one or a combination of these causes: an increase in demand for zinc; a reduction in its supply; a general increase in the supply of money and hence in monetary demand for all goods; a reduction in the general demand for money. How do we know which particular theory applies in these particular cases? Only by looking at the facts and seeing which theories are applicable. But whether or not a theory is applicable to a given case has no relevance whatever to its truth or falsity as a theory. It neither confirms nor refutes the thesis that a decrease in the supply of zinc will, ceteris paribus, raise the price, to find that this cut in supply actually occurred (or did not occur) in the period we may be investigating. The task of the economic historian, then, is to make the relevant applications of theory from the armory provided him by the economic theorist. The only test of a theory is the correctness of the premises and of the logical chain of reasoning.5

The currently dominant school of economic methodologists—the positivists—stand ready, in imitation of the physical scientists, to use false premises provided the conclusions prove sound upon testing. On the other hand, the institutionalists, who eternally search for more and more facts, virtually abjure theory altogether. Both are in error. Theory cannot emerge, phoenixlike, from a cauldron of statistics; neither can statistics be used to test an economic theory.

The same considerations apply when gauging the results of political policies. Suppose a theory asserts that a certain policy will cure a depression. The government, obedient to the theory, puts the policy into effect. The depression is not cured. The critics and advocates of the theory now leap to the fore with interpretations. The critics say that failure proves the theory incorrect. The advocates say that the government erred in not pursuing the theory boldly enough, and that what is needed is stronger measures in the same direction. Now the point is that empirically there is no possible way of deciding between them.6 Where is the empirical “test” to resolve the debate? How can the government rationally decide upon its next step? Clearly, the only possible way of resolving the issue is in the realm of pure theory—by examining the conflicting premises and chains of reasoning.

These methodological considerations chart the course of this book. The aim is to describe and highlight the causes of the 1929 depression in America. I do not intend to write a complete economic history of the period, and therefore there is no need to gather and collate all conceivable economic statistics. I shall only concentrate on the causal forces that first brought about, and then aggravated, the depression. I hope that this analysis will be useful to future economic historians of the 1920s and 1930s in constructing their syntheses.

It is generally overlooked that study of a business cycle should not simply be an investigation of the entire economic record of an era. The National Bureau of Economic Research, for example, treats the business cycle as an array of all economic activities during a certain period. Basing itself upon this assumption (and despite the Bureau’s scorn of a priori theorizing, this is very much an unproven, a priori assumption), it studies the expansion—contraction statistics of all the time-series it can possibly accumulate. A National Bureau inquiry into a business cycle is, then, essentially a statistical history of the period. By adopting a Misesian, or Austrian approach, rather than the typically institutionalist methodology of the Bureau, however, the proper procedure becomes very different. The problem now becomes one of pinpointing the causal factors, tracing the chains of cause and effect, and isolating the cyclical strand from the complex economic world.

As an illustration, let us take the American economy during the 1920s. This economy was, in fact, a mixture of two very different, and basically conflicting, forces. On the one hand, America experienced a genuine prosperity, based on heavy savings and investment in highly productive capital. This great advance raised American living standards. On the other hand, we also suffered a credit-expansion, with resulting accumulation of malinvested capital, leading finally and inevitably to economic crisis. Here are two great economic forces—one that most people would agree to call “good,” and the other “bad”—each separate, but interacting to form the final historical result. Price, production, and trade indices are the composite effects. We may well remember the errors of smugness and complacency that our economists, as well as financial and political leaders, committed during the great boom. Study of these errors might even chasten our current crop of economic soothsayers, who presume to foretell the future within a small, precise margin of error. And yet, we should not scoff unduly at the eulogists who composed paeans to our economic system as late as 1929. For, insofar as they had in mind the first strand—the genuine prosperity brought about by high saving and investment—they were correct. Where they erred gravely was in overlooking the second, sinister strand of credit expansion. This book concentrates on the cyclical aspects of the economy of the period—if you will, on the defective strand.

As in most historical studies, space limitations require confining oneself to a definite time period. This book deals with the period 1921–1933. The years 1921–1929 were the boom period preceding the Great Depression. Here we look for causal influences predating 1929, the ones responsible for the onset of the depression. The years 1929–1933 composed the historic contraction phase of the Great Depression, even by itself of unusual length and intensity. In this period, we shall unravel the aggravating causes that worsened and prolonged the crisis.

In any comprehensive study, of course, the 1933–1940 period would have to be included. It is, however, a period more familiar to us and one which has been more extensively studied.

The pre-1921 period also has some claim to our attention. Many writers have seen the roots of the Great Depression in the inflation of World War I and of the post-war years, and in the allegedly inadequate liquidation of the 1920–1921 recession. However, sufficient liquidation does not require a monetary or price contraction back to pre-boom levels. We will therefore begin our treatment with the trough of the 1920–1921 cycle, in the fall of 1921, and see briefly how credit expansion began to distort production (and perhaps leave unsound positions unliquidated from the preceding boom) even at that early date. Comparisons will also be made between public policy and the relative durations of the 1920–1921 and the 1929–1933 depressions. We cannot go beyond that in studying the earlier period, and going further is not strictly necessary for our discussion.

One great spur to writing this book has been the truly remarkable dearth of study of the 1929 depression by economists. Very few books of substance have been specifically devoted to 1929, from any point of view. This book attempts to fill a gap by inquiring in detail into the causes of the 1929 depression from the standpoint of correct, praxeological economic theory.7

MURRAY N. ROTHBARD

• 1The depression of 1873–1879 was a special case. It was, in the first place, a mild recession, and second, it was largely a price decline generated by the monetary contraction attending return to the pre-Civil War gold standard. On the mildness of this depression, particularly in manufacturing, see O.V. Wells, “The Depression of 1873–79,” Agricultural History 11 (1937): 240.
• 2Even taken by itself, the “contraction” phase of the depression, from 1929–1933, was unusually long and unusually severe, particularly in its degree of unemployment.
• 3It must be emphasized that Ludwig von Mises is in no way responsible for any of the contents of this book.
• 4This is by no means to deny that the ultimate premises of economic theory, e.g., the fundamental axiom of action, or the variety of resources, are derived from experienced reality. Economic theory, however, is a priori to all other historical facts.
• 5This “praxeological” methodology runs counter to prevailing views. Exposition of this approach, along with references to the literature, may be found in Murray N. Rothbard, “In Defense of ‘Extreme A Priorism’,” Southern Economic Journal (January, 1957): 214–20; idem, “Praxeology: Reply to Mr. Schuller,” American Economic Review (December, 1951): 943–46; and idem, “Toward A Reconstruction of Utility and Welfare Economics,” in Mary Sennholz, ed., On Freedom and Free Enterprise (Princeton, N.J.: D. Van Nostrand, 1956), pp. 224–62. The major methodological works of this school are: Ludwig von Mises, Human Action (New Haven, Conn.: Yale University Press, 1949); Mises, Theory and History (New Haven, Conn.: Yale University Press, 1957); F.A. Hayek, The Counterrevolution of Science (Glencoe, Ill.: The Free Press, 1952); Lionel Robbins, The Nature and Significance of Economic Science (London: Macmillan, 1935), Mises, Epistemological Problems of Economics (Princeton, N.J.: D. Van Nostrand, 1960); and Mises, The Ultimate Foundation of Economic Science (Princeton, N.J.: D. Van Nostrand, 1962).
• 6Similarly, if the economy had recovered, the advocates would claim success for the theory, while critics would assert that recovery came despite the baleful influence of governmental policy, and more painfully and slowly than would otherwise have been the case. How should we decide between them?
• 7The only really valuable studies of the 1929 depression are: Lionel Robbins, The Great Depression (New York: Macmillan, 1934), which deals with the United States only briefly; C.A. Phillips, T.F. McManus, and R.W. Nelson, Banking and the Business Cycle (New York: Macmillan, 1937); and Benjamin M. Anderson, Economics and the Public Welfare (New York: D. Van Nostrand, 1949), which does not deal solely with the depression, but covers twentieth-century economic history. Otherwise, Thomas Wilson’s drastically overrated Fluctuations in Income and Employment (3rd ed., New York: Pitman, 1948) provides almost the “official” interpretation of the depression, and recently we have been confronted with John K. Galbraith’s slick, superficial narrative of the pre-crash stock market, The Great Crash, 1929 (Boston: Houghton Mifflin, 1955). This, aside from very brief and unilluminating treatments by Slichter, Schumpeter, and Gordon is just about all. There are many tangential discussions, especially of the alleged “mature economy” of the later 1930s. Also see, on the depression and the Federal Reserve System, the recent brief article of O.K. Burrell, “The Coming Crisis in External Convertibility in U.S. Gold,” Commercial and Financial Chronicle (April 23, 1959): 5, 52–53.